Will an economic downturn in the rest of the world drag the U.S. into a deep recession?
Although there is more risk of such a negative impact from abroad now than in previous U.S.
slowdowns, we don't expect the mutually reinforcing downward spiral that some commentators
fear. While the American economy will decline further in the coming months, we don't foresee a
long or deep downturn. And we believe that the drag from abroad will be relatively small. Based
on what we now know, we're in sync with the consensus forecast that the U.S. GDP in 2002 will
be about 1 percent higher than in the current year.

Concern about the U.S. economy being pulled down further by weakness abroad stems
from the fact that a slowing of income growth in other countries means less demand for U.S.
exports. It's easy however to exaggerate the likely magnitude of that effect on the U.S. economic
performance in the coming year. Although forecasters generally see a slowdown in foreign
economies, the decline in growth is expected to be very small. Moreover, the impact of a
slowdown in the growth of foreign incomes on our exports is also very limited. When these two
factors are put together, the net impact on the U.S. economy is unlikely to be substantial.

Consider first the probable extent of the foreign slowdown. Although the past few months
have seen little growth in the rest of the industrial world, the most recent poll of economic
forecasters by the Economist magazine projects that the European economies will grow next year
by 1.5 percent, only about 0.2 percent less than the growth over the past 12 months and about 0.1
percent less than the growth forecast for the current year as a whole. While a 1.5 percent growth
rate is nothing to brag about, a decline from the current 1.7 percent provides little reason to worry
about a substantial decline in the demand for U.S. exports.

In Canada, our largest trading partner, growth is projected to decline only marginally,
from 2.1 percent in the most recent year to 1.8 percent in 2002. And while Japan's decade long
slump is projected to continue, the Economist poll indicates that the pace of decline will be less
in 2002 than in the current year, increasing the likelihood of greater demand for imports. Finally,
the forecasters expect that the rate of GDP growth in the major emerging market economies will
be faster in 2002 than it has been over the past 12 months.

If the forecasters are correct, there is no reason to fear that economic weakness abroad
will drag down U.S. exports and the overall pace of economic activity in the United States. But
what if the forecasters are too optimistic and the foreign economies grind to a complete standstill
in 2002? Even then, the impact of the rest of the world on the U.S. economy would be relatively
small.

A decline in the European growth rate from 1.6 percent in 2001 to zero in 2002 would cut
Europe's GDP by about $160 billion relative to the basic forecast. European household incomes
would stagnate and European businesses would have lower profits. Most of the resulting hit on
spending would of course fall on goods and services produced in Europe. Experience with past
fluctuations implies that a $160 billion slowdown in European GDP from the currently projected
level would shrink European imports from the rest of the world by less than $30 billion. Only
part of this relatively small amount would fall on U.S. exports. Lower European demand for the
exports of other countries the GDPs of those countries and therefore their imports from the
United States. But even allowing for this indirect effect, a decline of European growth to a
complete economic standstill would cut U.S. exports by less than $25 billion, equivalent to a
reduction of about 0.2 percent in our growth rate.

A similar analysis for other countries would imply even smaller adverse effects. Japan
spends less than one-sixth of its GDP on imports and much of that goes for oil and food that
don't come from the United States. It's hard to imagine a plausible scenario in which weakness
abroad cuts U.S. growth next year by as much as 0.5 percent of GDP or $50 billion.

A $50 billion cut in U.S. exports would fall primarily on our manufacturing firms and
workers, a sector that is already the most hard-hit in the current slowdown. And while $50
billion is less than 0.5 percent of total GDP, it would be more than 3 percent of manufacturing
sales. A much greater than expected decline in growth in the rest of the world would be painful
for our export industries but would not be enough to wipe out the projected U.S. growth next
year.

There are of course risks to any forecast. An oil crisis, a substantial weakening of
consumer confidence, or a sharp fall of the stock market are some of the ways in which the
positive growth projected for the United States in 2002 could be reversed. But if there is a
prolonged recession in the United States, it is unlikely to be the result of a reduced demand for
U.S. products from the rest of the world.